Making use of unsecured credit lines can be dangerous if one uses them to buy things he or she cannot afford. It can quickly snowball into a deadly spiral of multiple debts if left unwatched.
Nevertheless, they can be useful if someone uses them to pay off another debt which has a higher interest rate. The interest rate offered by the typical fund transfer promotion is much lower than that charged by a credit card, which can run up to 24% p.a.
But it might be difficult to decide which fund transfer promotion to take up. The different interest rates (and admin fees) offered can be confusing to the consumer. Sometimes, knowing what to ask can easily bring you a better deal.
Here’s an example.
This morning, I received a call from a bank offering me a fund transfer with a fixed admin fee of 2.5% with 0% interest for 6 months. If you take a 6 month loan with an fixed interest of 2.5% with NO monthly payments, this is an effective interest rate of 5% p.a.
However, because there is a minimum payment to be made every month (usually 3% of outstanding amount), the effective interest works out to be about 5.4% p.a. For these kind of packages with a fixed admin fee, there is no incentive for paying off the loan earlier as the full interest would have already been charged up front.
Anyway, I know the 2.5% admin fee is a bit on the high side as it usually ranges from 1.5-2.5% (typically closer to 2%). So I asked for a better deal.
The counter offer was a transfer with a 1% admin fee and 1.99% p.a. interest charge on the reducing balance. A rough feel of the annual interest rate is 1×2 +1.99 =3.99% p.a. Again, as there is a minimum amount to be paid every month, the effective interest rate works out to be about 4.14% p.a.
This is much better than the first offer but there is always the chance of something better.
So, I asked for a transfer that has no admin fee.
The offer this time was a fund transfer with no admin fee but 3.99% p.a. interest on the reducing balance. There is no need to calculate the effective interest rate as it is the same – 3.99% p.a.
This deal is the best of all three offers. Not only because of the lower effective interest rate, but also because you can pay off more than the minimum each month and the absolute interest that you end up paying will be lower.
Just for the record, the best deals currently offered on the market charges 2.99% p.a. interest on the reducing balance with no admin fee.
The best deal that I have ever been offered was one that charges only 1.99% p.a. interest on the reducing balancing with no admin fee.
The worst deals are those with an admin fee and equal monthly installment payments. A 2.5% admin fee for a 6-month installment plan with equal monthly payments gives an effective interest rate of about 8.8% p.a. Ouch.